Lesson 1 : The Reality of the Markets What did Plato know about Trading? Probably nothing! But he has a great analogy which I‟m going to share in order to demonstrate some key concepts: * Our reality is based upon that which we perceive. * Often there is an underlying reality which we have just not seen. In describing the scenario, I‟ll share a short passage from Wikipedia, as it discusses Platos Allegory of the Cave… “…imagine a cave inhabited by prisoners who have been chained and held immobile since childhood: not only are their arms and legs held in place, but their heads are also fixed, compelled to gaze at a wall in front of them. Behind the prisoners is an enormous fire, and between the fire and the prisoners is a raised walkway, along which people walk carrying things on their heads “including figures of men and animals made of wood, stone and other materials”. The prisoners can only watch the shadows cast by the men, not knowing they are shadows. There are also echoes off the wall from the noise produced from the walkway. Is it not reasonable that the prisoners would take the shadows to be real things and the echoes to be real sounds, not just reflections of reality, since they are all they had ever seen or heard?” In other words…What we perceive as reality is not necessarily so. Often there is a deeper reality which we have just not seen. Or…That, which is perceived to be reality, is actually an illusion. The same applies to trading. My belief is that most people do not understand what a market is. They see a chart and perceive price movement and its resultant technical analysis patterns and indicator based signals. And they assume this is reality. Its all they know. And its all thats taught in the majority of books, websites and courses. Unfortunately, these traders are like the prisoners in the allegory of the cave. Chained to their viewpoint, they falsely believe in their version of reality, which is in fact an illusion. They fail to perceive the fact that there is a much deeper truth to the markets. A reality that I believe makes ALL the difference in trading. Most traders are Trading the Shadows*, usually with no understanding at all of the reality behind those shadows. The reality of the markets (which well discover shortly) is projected as price chart patterns or their derivative indicators. These are the shadows, or the illusion. Most people perceive the shadows as the game. They think its all about the price, or the patterns or the indicators, so they try to trade them. Its not about that – the game is about something else entirely. Finding no success with their setups, or indicators, traders go on the search for new indicators, new setups, new parameters. But they‟ll never find the truth, because they‟re trading the shadows. They don‟t perceive the reality. Successful trading requires seeing the reality that forms the shadows. That is, the reality that produces the price movement, then indicators and the patterns. The reality is not just price. It exists at an even deeper level of understanding – that which creates price and price movement. Cause and Effect Just quickly, well look at this in one other way, which some of you may find more useful. Lets look at price movement through a different lens – that of Cause and Effect. Price movement and any resultant indicator and pattern based signals are the EFFECT. Most traders focus here. Thats all they see and thats what they try to trade. Instead, to truly understand the markets, we need to focus on the CAUSE. What causes price to move? Thats where we focus, because: * Only then can we understand the reality of the markets. * And only then can we understand how to identify when a move is likely to start, when its likely to continue and when its likely to end. Most people focus solely on price. They observe the bearish breakout as price broke below a period of sideways consolidation, or a short-term head and shoulders patterns (marked by labels S-H-S). If theyre pattern based traders they‟d be looking to enter short either at the break of the head and shoulders neckline (point B), or on the first confirmed close below the neckline (point C). Indicator based traders would also likely enter in the vicinity of C as their signals are typically based on a lagging derivative of price, which wont trigger entry until significant movement has occurred in the new direction. The problem for these traders is theyre focusing on price. The price move is the EFFECT. These traders are simply responding to the effect, entering in the HOPE that the momentum of this move continues in the bearish direction, long enough for them to attain a profit. Hope is not good enough for me. A better way to trade is to understand the CAUSE of price movement. Although you don‟t see it yet, identifying the CAUSE in this example would have allowed you an entry in the vicinity of A, with an expectation that if price broke the area of B and the slightly lower support, movement would be clear until possible target areas in the vicinity of D and E. Had the move failed at B, sufficient opportunity would be available to scratch the trade for either a small profit or a breakeven result. * Understanding CAUSE allows you to identify potential moves before or as they occur. * Understanding CAUSE allows you to enter a price move earlier. * Understanding CAUSE allows you to understand why a price move is occurring. * Understanding CAUSE allows you to assess when a move is likely to continue and when its likely to end. * Understanding EFFECT only, means that all you can do is react to what has already occurred, usually well after it has already occurred, and then simply hope that sufficient profit potential is still available in the move. So, if the market is not price movement, patterns and indicators, then what is it? What is the reality? We need to start at some very basics – what is price and why does it move? That will lead us to a new understanding of the nature of the markets. The nature of markets is not price. Its something else entirely different. What is Price? Regardless of whether we‟re talking stocks, futures, foreign exchange, or any other product at all, price is the amount a buyer pays to acquire a product from a seller. Any one transaction involves a product, and two parties – the buyer and the seller. The seller holds the product. The buyer wants to purchase it. Price is the amount that they agree upon for the transfer of the product from the seller to the buyer. The key word in this sentence is…… agree… The buyer wants to buy at this price. The seller wants to sell at this same price. They come together. Theres a transaction. So, what is price? Yes, it is the dollar amount, or points value, that they agree to transact. But thats not how I want you to view it. Instead, view price as two parties making a buy and sell decision. From a trading perspective…Price is two traders making a buy and sell decision. Its a subtle difference, but its important. Now, markets don‟t transact all at one price… they move. Thankfully, otherwise there wouldnt be profit opportunity. As we mentioned before, most people are happy to just accept that markets are price movement. Im going to take us deeper. Now that we view price as not just the dollar or point value of each transaction, but of traders making buy and sell decisions, were going to look at how those decisions make price move. This will lead us to our deeper, and superior, understanding of the nature of the markets. How Does Price Move? Price movement is a function of supply and demand. In fact, as well see its deeper than that, again. Well soon be discussing what drives supply and demand. But for now, I need to discuss supply and demand; to be sure you understand this basic concept. Lets define the concept and the terms in simple (non-textbook) language: * Supply - is the amount of a product which sellers want to sell at a particular price. * Demand - is the amount of a product which buyers want to buy at a particular price. Price will move with changes in supply and/or demand. Lets look at some examples… First well look at an example that most people will be familiar with - a housing auction. In this scenario, we have a fixed supply – one house for sale. And we have a variable amount of demand, depending on the public perception of value. For a very nice house in a great location during times of strong economic growth, there might be a large crowd of potential buyers, all competing for the property. For an overpriced house, in a down-turning market, there may be only a small number of potential buyers, or possibly even none. For this example, we‟ll assume we have a large crowd of buyers, all desperate to take ownership of the property, all willing to buy at varying prices between say $650,000 and $750,000. The realtor opens the auction at $550,000. What happens next is that the bidders will compete with each other at ever increasing prices, hoping to be the last one standing at the end of the process. Initially price will increase rapidly, $575,000 - $600,000 - $620,000 - $640,000 - $650,000 - $660,000. As each bidder‟s maximum price is exceeded they‟ll drop out of the race. The rate of price increases may slow and bidders will typically take more time to consider their next move. If enough emotion is involved in the purchase, bidders may even exceed their pre-planned maximum price, desperate to ensure no-one else gets their property. $750,000 - $752,000 - $752,500 - $753,500. Eventually there will be no bidders left who are willing to pay a higher price, and the property is sold to the highest bidder. In this example, demand consisted of multiple buyers all wanting to buy and willing to pay higher prices to do so. Supply consisted of a single seller, willing to allow price to increase until there are no more buyers. Demand has overwhelmed supply, leading to price rallying. Price continued to rally until there were no more buyers willing to pay a higher price. Now lets consider a hypothetical example where there are two desperate sellers, offering for sale two essentially identical properties. Let‟s say two apartments side by side, with similar quality fittings and fixtures and similar view; essentially identical value. And let‟s assume there is only one buyer interested in purchasing a property. The process would now work in the reverse of the previous example. The buyer can afford to hold out, while the two sellers would be required to compete. The sellers would take turns lowering their asking price, until it reached a point at which one was not willing to go lower. Assuming the price was then acceptable to the buyer, a transaction could occur. Supply has overwhelmed demand. Price has fallen until there is no-one willing to sell at a lower price. Important point… its not just the number of participants that is most important, but the desperation, or urgency, with which they are seeking a transaction. Consider the original housing auction where buyers were once again willing to pay differing amounts up to a maximum of $750,000, but this time the owner was asking too much for the property. The auctioneer opened the bidding at $850,000. In this case there will be no bidding. No transaction will occur, despite multiple potential buyers and one seller. The only way for a transaction to occur is if either one or more of the buyers decide they absolutely must have the property, and are willing to pay a higher price by increasing their bid above their pre-planned maximum, or if the seller is willing to drop the opening ask price in an attempt to find buyers. Lets assume the seller is desperate to offload the property. The auctioneer will be instructed to lower the asking price in increments, until a buyer can be found and a sale can occur. In this case, despite only one seller, the desperation of that seller has been greater than the desperation of the buyers, resulting in price falling. Supply has overcome demand and price has fallen. Thats how the market works from a supply/demand perspective. Its a dual-auction process, with price auctioning both up and down depending on which force is dominant at the time – demand or supply. * Price rises while demand is greater than supply, and while those buyers are willing to pay higher prices. * Price rises until we run out of buyers, or until supply increases sufficiently to absorb all the demand. * Price falls while supply is greater than demand, and while those sellers are willing to sell at lower prices. * Price falls until we run out of sellers, or until demand increases to the point it absorbs all the supply. * Price movement is a function of supply and demand. Or more correctly…price movement is a result of supply/demand imbalance. And the supply/demand imbalance is created by trader’s sense of urgency to transact. Individual trader sentiment at any one time may be either bullish or bearish. The net effect though, when considering all traders operating within the market, will be either a net bullish, bearish or neutral sentiment. * Bullish sentiment leads to bullish orderflow resulting in price rising. * Bearish sentiment leads to bearish orderflow resulting in price falling. * Neutral sentiment leads to narrow range sideways price action. Note that price within these swings is not moving in a straight line – it fluctuates constantly. The market is comprised of buyers and sellers all competing through different analysis styles, on different timeframes, with different reasons for wanting to enter or exit. We dont know their individual reasons. Its the collective sentiment that matters. And price moves with whichever crowd most desperately needs to act. It comes down to sentiment of the market participants. Just as we discovered that price is two individuals making buy and sell decision, we have now established that price moves also as a result of the net effect of all market participants making individual trade decisions. Some people use fundamentals to make trading or investing decisions. Others use technicals. Others may even use lunar cycles. It doesnt matter. At the core level, it’s all just people making decisions. Price doesnt move up or down because of fundamentals or technicals. Individuals form an opinion about market direction. Some of them will act on their opinion – theyll make a decision to buy or sell. The sum of all the buy or sell decisions forms the collective sentiment of the crowd, which may be bullish or bearish. And this collective sentiment of all market participants, leads to a net bullish or bearish order flow, which moves price. The most fundamentally bullish stock will still fall if the sentiment of the crowd is bearish, and they dont want to own it. The most technically perfect breaking of a neckline of a head and shoulder pattern (which is supposedly bearish) will fail to reach its projected target, if the sentiment of the crowd at this point changes to bullish, and they all want to buy this stock. It’s not about the fundamentals or technicals. It’s about people… and the decisions they make about market direction. Price changes as supply and demand change… supply and demand change based on the beliefs of market participants, or more correctly on the decisions of market participants to act on their beliefs. Lets summarise this section – How does price move? * Price movement results from a supply/demand imbalance * Changes in supply and demand occur as sentiment changes within the market participants. * Price therefore depends on the bullish or bearish sentiment of market participants. * The net sum of all individual trader decisions and actions, form the Net Order Flow. * When Net Order Flow is bullish (demand greater than supply), price will rise. * Price continues to rise until we run out of buyers at higher prices, or until the higher prices attract sellers in sufficient quantity to overcome demand. * When Net Order Flow is bearish (supply greater than demand), price will fall. * Price continues to fall until we run out of sellers at lower prices, or until the lower prices attract buyers in sufficient quantity to overcome supply. Or more simply: Price moves as a collective result of all traders’ What Are Markets? Most traders simply see markets as price movement. They look at a chart and they filter all the price action into what they consider to be significant movement, usually represented by either charting patterns or indicator based setups. To return to Platos Allegory of the Cave, these traders are trading the shadows; the illusion. Theyre not considering the reality underlying the price movement. Or if you prefer to use the cause/effect analogy, these traders are trading the effect. Theyre not considering the cause of price movement – the underlying reality, or the nature of the market, which is…Traders making trading decisions. Traders make trading decisions; which leads to a net order flow; which leads to the effect – price movement. We see markets as a collective group of traders all making trading decisions and taking action based upon their bullish or bearish sentiment. This leads to a net bullish or bearish orderflow, which leads to the effect – price movement. You may think this is irrelevant. Youd be wrong. Its a subtle difference, but its essential. Until you get the significance of this, youll be stuck in the indicator and pattern-based Technical Analysis treadmill, simply observing past price movement and trying to predict future price movement. Markets are traders making trading decisions. Markets are not the resultant price movement. When we look at a chart, dont see it as price movement. See it as traders making decisions whether to buy or sell or stand aside. You need to see when theyre in pain. You need to see when theyre feeling greed. Only then will you be operating in the real market, profiting from the traders who are operating under false assumptions and a lack of understanding of the game. Lets look at an example on the second image attached below. Dont look at figure and just see a breakout below support at point A. Learn to view all price movement from the perspective of other traders, and how the price movement influences their decision making. See the bears entering at point A with anticipation and greed, with their sell orders, expecting lower prices to follow the breakout. See the bulls who bought at point B expecting support to hold. These people are panicking – theyre in drawdown – the market is moving fast against them. Those bulls who arent frozen will be activating their stops, adding to the bearish pressure, forcing price even lower. Traders, making trading decisions. When price stalls at point C, dont just see a swing low. See the shorter-term traders who caught the breakout, covering their position to take profits. This adds to bullish pressure and slows the breakout move. See also some new bulls deciding to enter long, in the hope of catching a breakout failure. These trader decisions, and their resultant buy orders, were enough to tip the supply / demand equation to the bullish side, causing a retrace. Dont just see a breakout pullback at point D. See the traders who missed the original breakout, enthusiastically selling as price gives them a second opportunity to enter short, or perhaps those who did catch the original move deciding to add to their position. Both scenarios adding to the bearish pressure. See the traders who were long from point B, having suffered through the drawdown to point C, enthusiastically selling as the pullback offers them an opportunity to get out at close to their entry point for a reduced loss. Once again, adding to the bearish pressure. See the more astute short-term traders who entered long at C in anticipation of a scalp back to the breakout point taking their profits via a sell order, further adding to the bearish pressure. Then as this bearish pressure causes price to move down again from point D, see those longs who bought at C in expectation of a breakout failure and longer term reversal back to new highs, having to sell in panic as they realise that the breakout failure did not occur and theyre stuck in a losing position. All these trading decisions lead to a bearish sentiment, bearish pressure, bearish net order flow, and therefore a price fall. Dont look at the third image attached below and see a pullback within a trending market at point A. Learn to view all price movement from the perspective of other traders, and how the price movement influences their decision making. Large numbers of traders have a natural tendency to try to fight a trend. These people will be looking for any opportunity to enter long, in the hope of catching the reversal. See these hopeful bulls entering in the vicinity of B with anticipation and greed, with their buy orders, expecting higher prices and an opportunity to brag to their friends about how they caught the reversal. Their bullish orderflow, added to the pressure of those shorts who take profits at new lows (also a buy order), being sufficient to overcome the downward price movement and commence a pullback. As price gets to the area of point A, see the fear levels rise within the longs who bought at B, as price stalls for three candles. See the more astute traders trading with the trend and taking the pullback to point A as an opportunity to enter short, creating bearish pressure which opposes the short-term pullback. The see the panic set in at point C as the market thrusts back downwards, and the longs from B bail out of their positions, some smarter ones at breakeven, but most at a loss as they watch in disbelief as the market takes out their stops and their reversal is proven to be just a pullback within the trend. The reality of the market is traders making trading decisions. Its all about people, not price. Individual traders make trading decisions based on their perception of the market. The net effect of all traders operating within the market will result in a net bullish, bearish or neutral sentiment, which leads to bullish, bearish or neutral orderflow and its corresponding price movement. Learn to view all price movement from the perspective of other traders, and how the price movement influences their decision making. When we look at a chart, dont see it as price movement. See it as traders operating through a foundation of fear and greed and all of the perceptual limitations and heuristics and biases which influence their decisions and subsequent actions. You may feel this slight change of perspective is minor, and perhaps irrelevant. Youd be wrong. Its vitally important to defining the way we trade, and has great relevancy to the next section, where we learn what the game of trading is really all about. How Do We Profit? First an apology… like the previous section, this is going to appear ridiculously basic to anyone who has been around markets for a while. Please dont skip it. Theres a good likelihood, especially if youre not consistently profitable, that youve missed some key concept. In order to understand the reasons WHY my strategy works, you need to get the foundation right. Lets assume our objective with trading is to profit from the markets. For the majority of us (with the exception of some options traders) profit comes from capturing price movement. In the fourth image attached below, this may be via buying at A on the trend pullback and selling at the overextended highs of B. Or it may be via selling short at the downtrend pullback C and covering at the stall at point D. Profit comes from movement of price and your ability to buy lower and sell higher, or sell higher and buy lower. Heres an important point though. Profit requires movement of price AFTER your point of entry. Lets consider this from the perspective of other traders and our new understanding of the nature of the markets and price movement. Consider a long position. For it to profit, you must have bullish price movement after your entry point. Bullish price movement comes from bullish orderflow which comes from net bullish sentiment – traders making buying decisions. So to profit, other traders must be making their buying decisions at the same time as, and after, you make your buying decision. The concept is the same for a short position. For it to profit, you must have bearish price movement after your entry point. Bearish price movement comes from bearish orderflow which comes from net bearish sentiment – traders making selling decisions. So to profit, other traders must be making their selling decisions at the same time as, and after, you make your selling decision. Without that continuing orderflow supporting your decision, and coming after your decision, price cannot move in your favour and you will not profit. Analysis for Profit The True Basis For Profit - The aim of your analysis then MUST be the following: * To buy at areas where you KNOW others will buy after you, because their buying will create the net orderflow or bullish pressure to drive prices higher, allowing you opportunity to profit, or * To sell at areas where you KNOW others will sell after you, because their selling will create the net orderflow or bearish pressure to drive prices lower, allowing you opportunity to profit. Or more simply; buy at areas where others will buy after you, and sell at areas where others will sell after you. To do that, your analysis must focus on areas of trader decisions. What are other traders thinking? Where will they be making their trading decisions? Identify areas at which others will be making buying decisions, and you can profit. But Can We Know What Other Traders Are Thinking? Individual trader decisions and actions cannot be known. We all trade for different reasons. We all make our trading decisions for different reasons. There are so many different external influences on our decision making at any particular time… fundamentals, technicals, intermarket themes, general market sentiment (risk appetite / aversion), comments by media, economists, company CEOs, monetary officials, and so on. Combine that with the internal factors which impact on our decision making… memory limitations, information processing limitations, perceptual errors, decision making heuristics & cognitive biases, our emotional state, values and belief systems, our susceptibility to distraction, and even our susceptibility to crowd psychology influences such as group think, and its just not possible to know how any one person will think or act. Price is not a true representation of fundamental value, but is a representation of the sentiment of the crowd, which is based upon flawed analysis of market information and irrational decisions. Price movement is therefore based on psychology. It is emotional, rather than mathematical. It cannot be forecast or predicted with current mathematics or physics, and I expect it never will be. Individual trader decisions are unknown. And we can conclude from that statement that the collective sentiment at any one time should also be unknown. However, our cause is not lost. While that generally is true, remember that an imbalance of supply and demand doesnt actually mean greater numbers on one side, but rather an imbalance in desperation, or urgency. We can, through our analysis, identify areas where significant groups of traders will be under extreme stress, and therefore feel forced to act in a reasonably predictable manner. In times of stress, human decision making and actions become a lot more predictable, and are typically carried out with greater desperation and urgency. Exactly the qualities were seeking. This is not guaranteed, but generally quite reliable. Consider human nature, in particular crowd behavior, at other times of stress. Imagine a shopping centre. Movement of any individual within that shopping centre will be largely unpredictable. And collectively, movement of all shoppers will appear essentially random. Contrast this with their movement upon activation of a fire alarm. Their movement will now be somewhat more predictable, as all shoppers move (hopefully in an orderly manner) in the direction of the nearest exit. We apply this same concept to our market analysis. When are traders most under stress? * When a position has moved against them and theyre in drawdown. At some point theyre going to reach maximum stress at which time theyll finally accept theyre wrong and exit their position. * When a position in profit starts to move against them. At some point theyre going to reach maximum stress at which time theyll accept their trade is no longer right, and exit their position before the market can take the remainder of their profits. In other words, at the point where they perceive theyre wrong and are forced to act (in order to either minimise losses or minimise further reduction of profits. We aim to enter before or at the point of maximum stress, where traders are coming to accept they’re wrong. Their decision to exit is a means of relieving themselves of stress. This creates orderflow that takes our position to profit (provided of course you manage the trade well). The Real Trading Game The real trading game is one of analysing other trader decisions. Aim to understand all price action from the context of other traders decisions and actions. Aim to determine where large numbers of traders are going to be wrong in their decision making. The theory being that the point where they know theyre wrong will contain an increase in orderflow as their stops are executed. I aim to profit from this orderflow by entering at exactly this point, or earlier. To put it simply, I try to find the losers on the chart. Its a mercenary game – I profit from their loss. But thats the nature of this game and I accept that. Its so basic, but most traders just do not get the significance of this. Trading is all about people, and the decisions they make. Effective vs Ineffective Trading Strategies and Systems My next lessons will present you with a method of conducting market analysis, setup identification, and trade entry and management which are based upon the principles that we have discussed so far. This is an effective trading strategy as its based on the true nature of the markets and the trading game. An effective trading strategy is one based upon the analysis of the forces of supply and demand within the market, and assessment of how that will influence other traders’ decision making. Knowing how and why price moves allows us to identify areas on charts where, if price should go there, significant numbers of traders will be trapped in stressful situations and be forced to act. The resultant orderflow will create price movement. Effective analysis allows us to identify areas of potential higher probability setups, which provide lower risk if wrong and higher reward if right. Effective analysis allows us to actively manage our trades – holding them when price action confirms the other traders response is in accordance with our expectations, or allowing us to exit prior to our stops when price action does not act as expected. Effective analysis allows us to manage our price targets, through identifying areas on the chart where opposing orderflow will come into the market to limit any further profit opportunity. The fifth image attached below shows effective analysis. On price bar A, price broke below support level B. Breakout traders, and those operating off indicator based continuation signals, will likely enter on the move down, however effective analysis identifies the fact that this move occurs into an area of support in the vicinity of C and within the context of larger timeframe upwards trend (not shown). The lower prices into support are likely to bring bullish orderflow, opposing the breakout. We assess that, should the breakout fail these breakout traders will be forced to exit, creating a surge of bullish orderflow. Our entry triggers at D, with a stop below A and initial partial target at E where we expect some of the longs to take profit and therefore slow or halt the rate of climb. Partial profits will be taken here, with the remainder targeting the next level F. This is not the way the masses trade. Typically, their decision making is based on the common teachings of technical analysis, involving little or no analysis of the forces of supply and demand, and absolutely no thought as to how this is influencing the decisions and actions of other traders. Common application of technical analysis involves overlaying charts with numerous indicators, and then trading indicator based signals. Think about how your favorite indicator based setups work. What are they actually indicating? A trend following indicator such as a moving average cross (or any variation of this no matter how complex) is simply identifying the fact that price has already moved a certain distance, that distance being dependent on the formula and parameters defining the indicators. In assessing the validity of any other trading strategy, or in developing your own strategies, be sure to consider the following: * Has any explanation been provided as to why the strategy should work? * Does it identify areas at which other traders are likely to make trading decisions? * Does it consider the context within which this entry setup is occurring? In particular, does the higher timeframe structure and trend support the trade, or is it likely to create opposing orderflow and therefore limit the extent of any move and limit any profit potential? Certainly the never-ending supply of trading systems presented in the popular forums are clearly ineffective, having no consideration at all to the reality of this game – we need to be trading at areas where others will trade, after we do. Effective trading strategies do not simply recognise price movement, entering after it occurs, and hoping it continues. Instead, knowing that price movement is the effect of trader decisions, they work to identify the areas on the chart at which traders will be making decisions that are likely to be net bullish or bearish. Most other traders aim to find the effect of price movement. We seek the cause, and enter before them, allowing their order flow to add to ours to move our position into profit. We aim to enter with the professional traders, well before the retail public. And we aim to hold the position while the premise that led to this move still exists, until price reaches an area on a chart where we know traders will be making the opposite decision, creating an opposing force that could limit further price movement. Principles of my Effective Strategy Lets review the key principles or beliefs upon which my whole strategy, an effective trading strategy, is based: * Profits on a single trade come from identifying potential directional price movement before it occurs, and acting on that belief. Profits therefore require price movement. * Price movement represents changes in supply and demand. Whenever demand exceeds supply, price will rise. Whenever supply exceeds demand, price will fall. * Changes in supply and demand occur as sentiment changes within the market participants. * Price movement therefore depends on the bullish or bearish sentiment of the market participants. * Price action is determined by human decision making. While individual trader decisions are generally unpredictable, as we cannot know the factors and limitations that apply to that individuals decision making potential, this is not necessarily the case when under extreme stress. * Human action in times of stress is somewhat predictable (on a probabilities basis, not a certainty), in particular those times when our analysis is proven inaccurate and were in a losing trade. At some point, we‟re going to have to exit to minimise the pain. Therefore, by identifying times at which a large enough segment of the trader population will be experiencing stress, we can identify areas of potentially higher probability setups. * Because you will not win 100% of trades, success has to come from a series of trades, which result in a profit after subtracting the losses and expenses from the wins. * Consistent profits over a series of trades can only occur if the strategy contains an edge, such that: a) Analysis is skilled enough to identify these areas at which traders are under stress, therefore presenting higher probability setups. b) Trader focus, discipline, confidence and psychology are sufficiently developed to identify the lower risk entries within these setup areas and take appropriate action to enter the trade. c) Position sizing and risk management are clearly planned in order to minimise damage to the equity balance in the event that this trade is one of the many which will lose (whether due to our analysis being wrong, or the sentiment changing within the market). d) The trader has sufficient experience to manage the trade in such a way as to minimise loss and maximise any gain. * It is possible to develop a strategy that identifies higher probability setups. Well discuss that in future lessons. * It is possible to learn appropriate position sizing and risk management. * It is possible to gain experience in the markets, improving our efficiency with trade management and exits, although due to the uncertainty within the market this area will never be mastered. * It is possible to master our trading psychology, such that fear provides minimal disruption to our ability to follow our planned processes and routines. * As a result, it is possible to profit from the markets. Conclusion This lesson has provided you with a new way of viewing the markets, and the way to profit within this environment. Markets are not price movement. They are traders making trading decisions. The way to profit on a consistent basis is through finding those opportunities where there is a higher probability of a sufficient number of traders making trading decisions, which will lead to net order flow in a particular direction, and then acting to trade with this orderflow. Weve seen that individual trader decisions are usually unpredictable, leading to no or minimal edge in the markets. However at times of stress they become much more predictable. Our trading approach therefore needs to be based on this fundamental understanding of how to profit from the markets: * We identify areas at which traders will be experiencing stress, and will make trading decisions to relieve them of that stress, and then act before or with them in order to profit from the resultant orderflow. That is the basis behind the strategy well cover in the next future lessons. Enjoy your Weekend Guys and Happy Reading
Posted on: Fri, 21 Mar 2014 18:49:14 +0000
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